Banking | Pragmatic lending is better than naïve cautiousness

Neighbour’s envy, India’s pride: India’s main bourse — Dalal Street — captures this sentiment quintessentially like none other measured by the performance of S&P BSE Bankex yielding CAGR of 68 per cent and 302 per cent over a five-year and 10-year horizon, respectively.

Compare this with the Dow Jones US Banks Index yielding -2.4 per cent and 45 per cent during the same time, and the picture becomes vividly clearer. A closer look reveals an intriguing contradiction in the management of banks in two distinct economies embarking on a divergent developmental agenda. In the Indian context, previous measures including bank recapitalisation and the secular decline in non-performing assets (NPAs) position India's banking sector on a competitive pedestal. Macro-stability is evident in healthy forex reserves ($~600 billion), and a stronger rupee together with tempered inflation provides sufficient room to expand the banking balance sheet.

With a projected real GDP growth of 2.1 per cent for the United States in 2023, the prospect of fending off inflation without hampering growth remains one of the cornerstones of the US Federal Reserve. Adjusted for CPI at 4 per cent, a more sombre view emerges.

On the other end, the International Monetary Fund (IMF) has pegged India’s real GDP growth at 6.1 per cent even as inflation fears remain subdued, supported by CPI at 5 per cent. In this context, the debate surrounding the mandate of banks as engines of growth assumes enormous significance.

India’s household debt as a percentage of GDP increased from 8.6 per cent in 2013 to 14.68 per cent in 2023, while the figure for the US has ranged between 69 per cent to 66 per cent over the same time. The rationale for expanding credit among Indian households becomes eminently clear. As India sets an ambitious agenda in marking a transition towards attaining an aspirational societal status, it is only prudent to view banks and financial institutions as primary engines of growth. With the NPA ratio at 3.9 per cent as of March, concerns surrounding credit expansion remain exaggerated.

The slew of mergers in India’s banking sector creating large behemoths with expanded balance sheets provide a sufficient safety net in guarding against potential delinquencies. The Indian economy remains at an inflection point prompting an urgency to attain financial inclusion, and achieve a high middle-income status in the medium term. To see this through to fruition, asset creation accompanied by sustainable income generation remains pivotal. Here too, banks as prudential lenders to MFIs and NBFCs would help in reinvigorating the goal of financial empowerment.

Additionally, stability in macro-economic indicators infuses confidence in the ability of banks to manage exogenous shocks, which continue to dent the global economic outlook. The Capital Adequacy Ratio (CAR), a critical indicator of a bank’s financial health defined as total capital as a percentage of assets, remains competitive at 17 per cent comparing favourably with the two largest economies (US and China) both maintaining 15 per cent; and well above the internationally benchmarked Basel III requirement of 10.5 per cent.

The Indian economy has exhibited resilience against tailwinds surrounding the consecutive exogenous shocks of the Covid-19 pandemic and geopolitical volatility creating a strong buffer against the uncertainty. On the contrary, exacerbating the easy monetary policy — famously monikered as quantitative easing (QE) — enacted in the post-2008 financial crisis era, central banks across parts of the developed world resorted to fiscal stimulus through cash doles in direct response to boost demand during the protracted period of lockdown, thus triggering a massive spike in inflation.

These actions have inevitably prompted the spectre of spiralling interest rates, much to the chagrin of political will and consumer spending. India, on the other hand, adopted a sound monetary policy aimed at non-inflationary stimulus targeting the supply side in response to the pandemic. The resistance to engage in fiscal profligacy provided an impetus in maintaining inflationary stability manifesting in less punitive action on the interest rate front.

The prudential investment standards stipulated by the Reserve Bank of India (RBI) have also positively contributed to curtailing SVB-like fiascos, avoiding bank runs emanating from diminution in bond investments (interest rate hikes resulting in the downward spiral of bond prices). Indian banks have traditionally focused on bread-and-better banking or lending and borrowing operations. They have remained steadfast by avoiding dealing in sophisticated yet attractive treasury operations that lure high returns accompanied by higher risks.

Banking follies of the 2008 crisis are worth reminiscing about, given the risks associated with traditional banks doubling as hedge funds. Arguably then, as a nation seized on creating long-term assets, Indian banks need to adopt a calibrated exposure in serving capital needs of both retail and commercial sectors.

While idiosyncratic risks (company-specific) may not always be preventable, a growing economy of the size and scale of India can ill afford to let the scarcity of capital rule the roost, leaving the aspirations of households and businesses high and dry. Finally, loosening the purse in affording capital to unleash India's true potential should no longer be viewed as a misnomer, but as the new normal.

(Ullas Rao is Assistant Professor of Finance, EBS Dubai. X: @Ullasrao7)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.